News

Investors considering buying, or dumping, Capital One Financial COF-N should take their eyes off the stock market, analysts' reports and pundits' musings, and review the U.S. job market.

Capital One had $70-billion in managed credit-card receivables as of Sept. 30, placing the McLean, Va.-based lender fourth among banks after JPMorgan Chase JPM-N and Bank of America BAC-N, with $165-billion each, and CitigroupC-N, with $151-billion. The company's annualized ratio of net charge-offs to average loans for the third quarter was 4.53 per cent, and its loan-loss reserves kept up with that pace, covering 4.66 per cent of total loans.

With almost half of its assets (on a managed basis, including securitizations) in credit-card receivables, Capital One's prospects are more directly tied to the health of the U.S. consumer than its rivals.

Credit-card losses have a tendency to match the unemployment rate, which hit a 26-year high of 9.8 per cent in September. For the third quarter, the net charge-off ratio for Capital One's managed credit-card portfolio (including securitizations) was 9.59 per cent, up from 9.24 per cent in the second quarter and 6.10 per cent a year earlier.

Credit cards

Capital One's credit-card charge-off ratio for the third quarter was the best among the "big four," with ratios of 12.9 per cent for Bank of America and 10.3 per cent for JPMorgan. Citigroup breaks down its credit-card loss ratios differently, with a loss ratio of 10.15 per cent for Citi-branded cards and a whopping 13.3 per cent for retail-partner cards.

Credit-card delinquencies of 30 days or more also increased, to 5.53 per cent in the third quarter from 4.99 per cent in the second quarter and 4.34 per cent from a year earlier. Capital One had the lowest reported 30-day managed credit-card delinquency rate among the big four, except possibly for the Citi-branded cards. Citigroup only provided a 90-day delinquency figure for that portfolio, which was 2.37 per cent.

Capital One chief executive officer Richard Fairbank said during the company's conference call that the increase in the credit-card delinquency rate reflected, in part, seasonally low delinquency rates in the second quarter and also "some impact" from increases in credit-card rates earlier this year.

"Based on past experience, we expect this delinquency increase to be temporary, although we do expect it to lead to higher charge offs early next year," he said.

Mr. Fairbank also said: "The unemployment rate and, therefore, domestic card charge-off dollars are likely to remain stubbornly high throughout 2010."

Analysts' reactions are mixed

BernsteinResearch analyst Kevin St. Pierre said Capital One's main risk is a further rise in the unemployment rate, "above the 10 per cent range." He also cited uncertainty tied to the enactment early next year of the remaining provisions of federal credit-card legislation, even though Fairbank had said during the call that the company's revenue model would "remain largely intact" despite the legislation. St. Pierre has an "outperform" rating on Capital One.

Bank of America/Merrill Lynch analyst Kenneth Bruce said his firm wouldn't "rule out lower valuation levels should credit deterioration and consumer spending trends worsen more than expected."

Davenport and Co. analyst David West said the "pending adoption of FAS 166/167 may pose particular challenges, since 31 per cent of its receivables are in securitizations."

New statements from the Financial Accounting Standards Board (FASB) to which Mr. West was referring will result in Capital One moving some loans that had been sold to off-balance sheet conduits back on to the balance sheet in January. The company hasn't said how much of the affected loan pools will move on to the balance sheet, but there were $44.5-billion in credit-card receivables in the affected conduits as of June 30. Adopting the new capital standards may "require it to take various actions, including raising additional capital, in order to meet regulatory capital requirements."

In his recent report affirming a "sell" rating on Wells Fargo WFC-N, Rochdale Securities analyst Richard Bove said "the imposition of FAS 166 and 167 could result in a significant capital raise at the company."

A friendlier lending environment

Payroll processor ADP said in a report yesterday that job cuts by U.S. companies in October were at their lowest level in a year. That could signal that unemployment is about to crest after doubling in two years.

Capital One has done a smart job moving through the credit crisis by strengthening its balance sheet and improving its net interest margin. The company's credit-card underwriting has been more conservative than its competitors, as shown by its lower loss and delinquency ratios. As far as regulatory pronouncements on handling FAS 166/167, an interpretation that's friendly to banks seems likely, as regulators won't want to disrupt the industry by forcing capital increases.